Q. Consider the following extended classical economy (in which the misperceptions theory holds):
AD Y = 300 + 10(M/P).
SRAS Y = ?+ P - P^e
Okun's law (Y - ?)/? = -2(u - u)
Full-employment output ? = 500.
Natural unemployment rate u = 0.06.
a) Assume which the money supply M = 1000 and which the expected cost level P^e = 50. Illustrate what are the short-run equilibrium values of output, Y, the cost level, P, and the unemployment rate, u? Illustrate what are the long-run equilibrium values of these three variables?
b) Now Assume which an unanticipated increase raises the nominal money supply to M = 1260. Illustrate what are the new short-run equilibrium values of output, Y, the cost level, P, and the unemployment rate, u? Illustrate what are the new long-run equilibrium values of these three variables? In general, are your results consistent with an expectations-augmented Phillips curve?